Goodwill is an intangible asset of a company but also considered a capital asset. Although it may be an internally developed asset, goodwill is most commonly derived from the acquisition of one company by another company at a premium value. Included in the term "goodwill" can be such things as a company's customer list, the value associated with a brand name, solid customer relationships, loyal employees, and proprietary technology.
- Goodwill is an intangible asset, but also a capital asset.
- The value of goodwill refers to the amount over book value that one company pays when acquiring another.
- Goodwill is classified as a capital asset because it provides an ongoing revenue generation benefit for a period that extends beyond one year.
- Included in goodwill can be such items as customer relationships or proprietary technology.
- Capital assets are any assets that are not regularly sold as part of a company's ordinary business operations but owned because of their ability to help the company generate profit.
Because goodwill is not physical, such as a building or piece of equipment, it is considered to be an intangible asset and is noted as such on the balance sheet. Generally, the value of goodwill refers to or coincides with the amount over book value that one company pays when acquiring another.
In the event that a company pays less than book value when acquiring a company, it is considered as having taken part in a distress sale, and to have acquired negative goodwill.
Because goodwill is an intangible asset, it is very difficult to assign an accurate value or price to it. However, it can—at a minimum—be assumed to represent some increase in a company's value. The nature of goodwill, having components with subjective values, does present the potential risk of overvaluation. In the case of an acquisition, for shareholders of the acquiring company, overvalued goodwill may cause share values to fall.
According to the International Financial Reporting Standards (IFRS), the inexact nature of the value of goodwill means that it cannot be amortized, but it must be re-evaluated every year by the company's management. If the fair market value falls below historical cost (or the cost at which it was purchased), an impairment must be recorded to indicate the reduction in the goodwill's fair market value. An increase in fair market value, however, does not have to be documented in a company's financial statements. The calculation of goodwill deducts the fair market value of the acquired company’s assets and liabilities from the amount for which the company was purchased.
Understanding Capital Assets
A capital asset is any asset that is not regularly sold as part of a company's ordinary business operations, but it is owned and maintained because of its ability to help the company generate profit. Capital assets are expected to help a company generate additional profits or be of some benefit to the company for a period of time longer than a year. On a company's balance sheet, a tangible capital asset is typically included in the figure representing plant, property, and equipment.
What is considered a capital asset can depend a great deal on the type of business where the asset is utilized. For some companies, capital assets represent the overwhelming majority of the firm's total assets.
Goodwill is invariably classified as a capital asset because it meets the basic requirement for capital assets—it provides an ongoing revenue generation benefit for a period that extends beyond one year.